On Monday, CNBC interviewed renowned venture capitalist, Roger McNamee of Elevation Partners, was asked about AAPL's Monday morning announcement of 10 million iPhone 6 / 6+ units sold over the three-day period since the phone became available for sale on Friday, September 19th. While McNamee did offer some insights on the incredible sales, he shifted the conversation into a much more insightful point about where we (the inhabitants of the civilized world) are in the 'smartphone cycle'. In short, McNamee commented that the smartphone market is a mature market now and that nearly everybody
that will have a smartphone has one, and is likely going on to their second, third, and so on. In making that point, McNamee went on to talk about what really matters now in this mature market - for AAPL, that's iOS 8 - operating system that runs AAPL's services, applications and binds its broader ecosystem. Specifically, he mentioned that AAPL-Pay is going to be huge, and one example of how the world's most valuable company will stay ahead in the continuing evolution where we see diminishing returns on hardware innovation, and increasing utility of services that run off the software - it speaks to the ever-present notion that mobile hardware is becoming a commodity with the last big OEM entering the realm of phablets.
It's No Longer About Getting People In; It's About Making Them Stay
There have been a number of articles written since AAPL's keynote on September 9th that address its new AAPL-Pay service, which is set to debut in the United States in October and will run off of NFC chips in its latest 6 and 6+ handsets. Most of these articles talk about the prospects of the initiative in the context of "revenue and earnings accretion", and the conclusion is, it won't move the needle of a company running at $200B per year. I believe that while this contextualization is interesting, it is completely missing the point. AAPL-Pay is not about revenue accretion related to the reported $0.15 that AAPL will receive on every $100 of transactions using the service, it is about adding another link to the ecosystem chain that is going to inevitably lock iPhone users to the platform.
AAPL's Fully-Integrated Portfolio of Services That Will Keep the iPhone Installed Base Strong
In recent interviews post-launch, when Tim Cook talks about the iPhone, he does not shy away from discussing the phone's thin aluminum design, high-resolution retina HD screens, or its practical and reliable TouchID sapphire sensor button. However, when the topic shifts to what the iPhone means to AAPL, his context shifts to a discussion of 'value' predicated on an incredible convergence of "hardware, software, and services" with each component critical to the value of the other, and most importantly, a bundling that only AAPL can achieve. And he's absolutely right. Just today, there is an article on CNBC discussing that Samsung's tough times have less to do with AAPL's strength, and more to do with its co-dependence on GOOG, who provides the Android OS that Samsung, and nearly every other OEM runs on its smartphones. AAPL's "closed garden" approach to integrating hardware, software, and services enables services, functionality, and attributes, which include:
- TouchID (first a security lock for phone access, now a password enabler for a multitude of apps);
- iMessage - a ubiquitous way to read traditional SMS msgs on any AAPL device;
- iTunes / iTunes Match - media platform to rent, buy, stream, and manage all of your digital media including movies, tv shows, and music;
- iCloud Drive - storage feature for access to documents, pictures, and other media from any AAPL device;
- The App Store - 1.3M device-specific apps vetted and approved by AAPL for function, malware, conformity, and 'taste';
- iWorks - cloud-based productivity suite for word processing, spreadsheets and presentations;
- Find my iPhone - a systematic way to track the location of all of your AAPL devices from your iPhone to iPad to MacBook, locate them via a beacon sound, and remotely wipe if stolen;
- AAPL-Pay - a new NFC-based payments platform supported by processors who transact over 80% of all credit and debit transactions - to debut in October.
- Trust - it was reported this week that AAPL has potentially up to 885 million iTunes accounts with credit cards on file. If true, this would be a treasure trove that only further clarifies how / why AAPL was able to strike the deals it did to get the AAPL-Pay service to market. It also implies that those not supporting the service are likely working to get there. For the record, AAPL has previously stated it has 500 million iTunes accounts with credit cards on file.
- Uniformity - by April 2014, just about seven months after iOS 7.0's release, 87% of iOS devices accessing iTunes were running its latest operating system (OS), while its major OS competitor, Android, had its highest penetration (34%) running on Android 4.1 "Jelly Bean" - released in late June 2012.
While each of these items alone seem marginal, when aggregated, it forms an incredibly consistent ecosystem that enables convenience and security that a disjointed hardware and software platform approach can never replicate. AAPL has had its share of problems with iCloud, but those holes are quickly getting filled and it is very easy to see the residual effect - a growing platform with higher engagement, an increased willingness to embrace mobile commerce, and a halo effect of increased device purchases - in fiscal Q3, AAPL set June-quarter records of 35.2 million iPhones (with channel contraction), and 4.4 million Mac computers, especially impressive given the PC industry's continued contraction.
Square Pegs Won't Fit in Round Holes
Nobody has been able to create a ubiquitous mobile payments platform because they can't get the square pegs to fit in the round holes - the seamless coordination between the hardware maker, software provider, and third-party processors simply does not exist. GOOG Wallet has been out for over three years now and has seen very little penetration because of the inherent disconnect between the hardware from the likes of Samsung, HTC, and LG with a heavily fragmented operating system. Even if they got that type of cooperation, the inherent differences in the hardware alone make the application of the solution inconsistent, unreliable, and confusing.
Now that AAPL has had a year to refine TouchID, build relationships with merchants / credit card processors, and ensure the secure enclave in the device protects sensitive information, it will roll out a platform next month that will likely gain more traction in its first few months than GOOG wallet has been able to achieve in the three-plus years since it debuted in the United States.
A recent article by Nicole Arce of Tech Times summarizes much of this differentiation between GOOG Wallet and AAPL-Pay and the prospects for each:
"Both Apple Pay and Google Wallet use near-field communications (NFC) to send the user's payment information to the point-of-sale terminal. However, Apple says paying with Apple Pay will be as quick and easy as simply holding the iPhone on the contactless reader and tapping the finger on the screen...
Google Wallet, on the other hand, requires users to swipe their phones awake and enter a PIN. If one would take a look at the Google Wallet page on Google's website, it's not something that many people would easily understand. The page tells users they can use loyalty cards, share card information and scan bar codes, but that doesn't paint a picture of what Google Wallet can really do. Apple, on the other hand, creates the need for a mobile payment system by saying that carrying multiple credit cards is a hassle and the magnetic stripes they use aren't very secure at all. With Apple Pay, consumers can pay for their purchases at more than 200,000 stores nationwide by simply tapping their finger on their iPhones. Most people don't know where they can use Google Wallet to pay for their purchases.
"First of all, people don't know where they can pay with their phone or how to do that. Apple, which taught how to use their finger on a phone as opposed to a keyboard, will be able to pull this off."
A major difference between the two systems, however, is that Apple says Apple Pay will have no access to the user's purchase information except for the most recent purchases listed in Passbook, which also carries the user's credit card and bank account information. Google, on the other hand, sees information on the user's purchases, which could make or break the decision for any user to use Google Wallet. [Emphasis Added]
It is interesting that the last point in this article discusses access to data - if the quantity of iTunes accounts with credit cards referenced above is any indication, AAPL has sufficient "trust" within its ecosystem - which will be critical for mass adoption of a service based on sensitive personal financial information. Nobody knows whether AAPL will finally crack the code with the "true" mobile wallet, but if history is any indication, it is far more likely to succeed than any of its predecessors attempting to push this paradigm shift in the frequency and way that electronic payments are made.
I Want to See Some Numbers
In AAPL's quarterly SEC filings, it has a product category labeled "iTunes, Software, and Services", which includes revenue from:
- iTunes Store (net of payments made to media content providers)
- App Store (net of payments made to developers - AAPL's 30% retention)
- Mac App Store
- iBooks Store
- AppleCare / Licensing and Other Services
This product category will likely contain the revenue generated from AAPL-Pay. This product category ran at $17.7B of revenue over the trailing four quarters (FQ4 2013 - FQ3 2014), and grew at 16% year-over-year (FQ4 2012 - FQ3 2013). To put that in perspective, the revenue derived from this product category if considered a standalone company would place it #160 in the 2014 Fortune 500 rankings. Needless to say, this is an extremely important aspect of AAPL's business, not to mention its fastest growing product category.
In the famous movie, Wall Street, Charlie Sheen's character (Bud Fox) asks Michael Douglas' character (Gordon Gekko), "how many yachts can you waterski behind?" The question is essentially asking, "when is enough ever enough?", and is analogous to the questions that are creeping up very quickly on the majority of smartphone OEMs out there running fragmented hardware and software, which include:
- How much more does a user care about a 500 PPI screen over a 400 PPI screen?
- When will software skins provide more than just a layer of unnecessary features like eye-scrolling?
- When will the fingerprint sensor work reliably and in a natural ergonomic way?
- How much does a user care about having an octa-core processor or 3GB of RAM?
- How much better of a picture does a 40MP camera on a smartphone produce compared to an 8MP camera where one company optimizes the translation from exposure to the Image Signal Processor (ISP) to the System on a Chip (SoC) to create a photo?
These are relevant questions because unless the Android OEMs can each develop a blossoming 'ecosystem' with an annual run-rate approaching $20 billion that provides practical and intuitive everyday solutions, the only differentiation is in the "speeds and feeds" and gimmicky software skins. In short, the post-smartphone world isn't about getting people into your platform; the post-smartphone world is about making it hard to leave - which has everything to do with services, and nothing to do with specs.